Thursday, 10 April 2008

Citigroup - Less Than Meets The Eye

Citigroup has managed to get rid of $12 billion in loans it doesn't want for what seems to be a reasonable price, from Rueters:

Citi financing its $12 bln sale of loans: source

Citigroup Inc's (C.N: Quote, Profile, Research) plan to sell $12 billion of loans and bonds made to private equity firms is seen as a positive for the bank and the loan market, but the deal will leave the largest U.S. bank with exposure to those private equity firms even after the sale.

That's because Citi is financing much of the sale itself, according to a person familiar with the deal. It is lending some money to the private equity firms, which will combine it with some of their own money to purchase the debt.

Essentially, Citigroup is re-lending money, but on different terms. The new loans are obligations of the private equity firms, and Citi is selling the original loans to the firms at somewhere around 90 cents on the dollar.

"The bank still has some of the same risk, but they have a lot of equity in front of them, and it's not on their balance sheet anymore," said David Bailin, head of alternative investments at Bank of America, speaking at the Reuters Hedge Funds and Private Equity Summit. Bailin had no direct knowledge of the Citi deal.

After the sale, Citi would no longer have to mark down the original leveraged loans if their value falls further, a real possibility in the currently disrupted credit markets. It also allows the bank to confirm the recorded values of other leveraged loans in its portfolio.

Or is it a reasonable price? The part in bold is the most interesting. Basically Citi is lending private equity money to buy these loans at around $0.90 on the dollar. What isn't mentioned is that Citi has agreed to indemnify the buyers of the first 20% of losses.

So the real price is somewhere between $0.70 - $0.90. Mr Practical summed up the situation best on Minyanville's Buzz and Banter yesterday:

Less than meets the eye...

As investors bid up the Citigroup (C) stock price early on the news that the bank sold $12 billion of bad loans at not too much of a discount, perhaps they should look closer at the deal.

In order to get that price, C had to agree to indemnify the buyers of the first 20% of losses.

Citi obviously did the deal at this artificial price so that it would not have to mark down too significantly the rest of its portfolio. Not to let facts get in the way, but the price it sold the loans at, if you include the indemnification, is very poor.

Risk is high and growing.

Anything to avoid real price discovery is the name of the game. Even whilst Citi dodges another bullet, I suspect that will still need to eliminate their dividend to shore up yet more capital.